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Tuesday, August 29, 2006

Retail Details

By William Trent, CFA of Stock Market Beat

Value Line’s latest investment survey noted the slowdown in consumer spending, but suggests that there could still be some opportunities in retail.

Companies in the department store sector of the Retail Store Industry are generally faring well, but there are some clouds on the horizon in the form of the high consumer debt burden and a relatively low level of year-to-year spending growth in recent months. A sound economy was a prime factor behind the healthy same-store sales increases in 2005 for the department store companies in this group. That said, consumer spending, which accounts for about two-thirds of total economic activity, has been sluggish in recent months. The portion of disposable income devoted to paying off debt is at a record level, and a rising interest-rate environment has put a squeeze on many households in the U.S. In this environment, management effectiveness is particularly important in the Retail Store Industry and is an important differentiation point that investors should focus on when reading the company reports in this industry.

The Retail (Special Lines) Industry is comprised of a diverse group of companies and subsections with distinct business operations. These merchants cater to individuals with various levels of wealth. Therefore, as the economy has slowed in recent periods, those retailers that primarily focus on individuals with low-to-moderate incomes have experienced the greatest decreases in sales, while those that carry high-end merchandise have fared slightly better. Even so, this has forced many companies to work even harder to increase value for shoppers, which includes offering price discounts. It might also be worthwhile to seek out stocks of companies that have a loyal customer base. Based on this industry’s diversity, however, we think investors will find some appealing opportunities here. Long-term investors should pay particular attention to those companies that have growth initiatives under way, which should provide a boost to earnings over the next 3 to 5 years.

The main factors affecting financial results for the second quarter 2006 were lower than planned sales, and significantly lower gasoline profitability attributable to rising gasoline prices throughout the quarter. These factors were partially offset by significantly lower accruals for incentive-based compensation.

Looking at our traffic trends, as in the first quarter, our members shopped us less frequently but spent much more money on each trip. Interesting to note, more than 50% of the decline in trips was attributable to trips with basket sizes of $30 or less, which indicates a significant decrease in convenience or fill-in trips compared to last year’s second quarter. And three quarters of this decline was attributable to members who lived more than four miles from their nearest BJ’s. This is a trend that began in last year’s third quarter after the fuel spikes. As a result, we believe the traffic will turn positive midway through the third quarter when we cycle.

That is, unless oil prices continue to rise. What we don’t understand, given the relative convenience of other shopping outlets and the minimal potential cost savings for such a small order, is why anyone ever drove more than four miles to a BJ’s for a purchase of less than $30.

At any rate, higher fuel prices and a slowing housing market are beginning to pinch consumers. Just how much of a pinch it will be is the question.